All Aviation Articles By David Wyndham

Aircraft Chargebacks - What Are They?

In some companies, the term chargebacks sends shivers up the spine of the aviation manager. In others, it is a fact of life and a challenge that is met by aggressively marketing the value of the aircraft to the users. Chargebacks can drive utilization, but you can still prosper.

A chargeback is an attempt to allocate the cost of providing the air transportation service to the departments those that use it. In general, the business aircraft, due to its cost and limits to its availability, is restricted to providing air transportation to high value individuals or teams of individuals. How the use of the aircraft is restricted is fundamentally important key in deciding on a chargeback scheme.

If the aircraft is limited to a very small circle of senior executives, or even to one individual (e.g.,the CEO), then the cost of the aircraft can be allocated 100% to the (C-level) headquarters budget. The total cost of the corporate headquarters function is then allocated to the various business units by a common method.

If the aircraft use is made available to different departments, divisions or subsidiaries, then some method of charging those business units for its the use of the aircraft may be appropriate. The general chargeback principle is that those who use the aircraft pay an equitable share for that the use of the aircraft. Chargebacks can range from a 100% reimbursement of all costs to something less than full cost recovery.

There are three considerations pertaining to as to the charge backs method to be used:

1. Metering: How much is utilization of the aircraft to be restricted? High chargeback rates will reduce the aircraft usage while low (or non-existent) chargebacks encourage aircraft usage.

2. Consistency: Is there already an established protocol pattern at the corporate level for distributing other centralized costs? Can an existing policy may be applied to the aircraft?

3. Relevance: When using chargebacks, there must be an accurate accounting of the aircraft costs that supports the chargeback method.

According to the NBAA, about 44% of its corporate members use chargebacks.

When allocating the aircraft costs in proportion to its use, the corporation can elect to recover all or a portion of the costs. Again, the higher the cost, the less likely a business unit is to use the aircraft. With the aircraft, two of the most common chargeback allocations are the fully loaded cost allocation and the operating cost allocation.

Fully Loaded Cost Allocation

A fully loaded cost allocation is an attempt to allocate 100% of the aircraft costs among the users of the aircraft. If headquarters used the aircraft 67% of the time and sales, 33%, then sales should pay 33% of the aircraft budget.

Where this gets difficult is in budgeting and setting the rate. Rates can be by the hour, mile, or seat-mile. If the actual costs exceed the budget, how are the added costs to be recovered? Or, if costs are lower than budgeted, will funds be returned to the business units? Does the full allocation include depreciation of the aircraft or just its operating costs?

This method requires a clear understanding of the aircraft costs and an accurate budget.

Operating Cost Allocation

The operating cost allocation involves some formula to cover the Variable Operating Costs (fuel, maintenance, etc) and the Fixed Operating Costs (crew salaries, hangar, insurance, training, etc). The options range from a percentage of the variable costs to recovering 100% of those the operating costs.

This chargeback method, which can be in the form of an hourly cost or a seat-mile cost, also requires a clear understanding of the aircraft costs and an accurate budget.

This chargeback can be in the form of an hourly cost (if using the whole aircraft) or a seat-mile cost (if “buying” seats on a scheduled trip).

Other companies my use an external source for their chargeback. Most common Are the US URS SIFL rates and First-Class airfare.

SIFL rates

In the US, the Internal Revenue Service uses Standard Industry Fare Levels in imputing the value of private air travel for non-business/personal use. These IRS SIFL rates can also be used for the chargeback cost of the business aircraft. The IRS SIFL formula is based on distance and seats, not the actual cost of operating the aircraft.

First Class Airfare

This chargeback avoids the requirements for detailed aircraft accounting and assigns a predetermined First Class Airfare cost to the use of the aircraft.

There may be other formulas in use such as per mile allocations, an allocation of the depreciation of the aircraft, or a hybrid-mix of the above formulas.

“Flight Department Companies”

Business aircraft operate in the US under FAR Part 91 and are classified as noncommercial transportation, whereas FAR Part 135 allows for commercial transportation for which compensation is collected. However, the IRS may question the aircraft chargebacks and in some cases, may reallocate them during an audit. Care must be taken to avoid any action that either suggests or creates a separate company to provide air transportation services to the corporation (even between subsidiaries within the corporation) unless that separate company holds a Part 135 certificate. For corporations that own an aircraft for its own use, However, chargebacks are an acceptable way to allocate the use of the business aircraft among the company’s users.

The chargeback allocation needs to reflect how the company values the use of the business aircraft. If done with that value in mind, it can be useful to assign a cost to a limited asset of the business aircraft. Thus entities within the company are using the business aircraft when it is most effective to do so. Using chargebacks just to throttle use of the aircraft can be disastrous.

Does your company have a chargeback system? What is it and how bad or good has it been?

Use Caution When Comparing Aircraft Costs

When comparing aircraft costs, understand what costs are included, what costs aren’t, and how the costs are calculated. If you don’t take all three into account, you can end up with cost data, that although technically correct when viewed alone, is an invalid comparison.

Let’s take an easy one. Fuel How much do you spend on fuel? We did this for a benchmark client, asking what their cost per gallon was for fuel at home and on the road, as well as their annual fuel budget. Seemed straightforward until I started looking at the results. At home, several operators reported fuel costs of less than $2.50 per gallon. This was when then national average was over $5 per gallon. I was able to follow up with the operators and I found out two things:

1. These operators had their own fuel farms.

2. The cost of fuel to them was the wholesale cost when the truck pumped the fuel into their storage tanks.

These operators correctly and accurately reported that their fuel cost at home was less than $2.50 per gallon. The cost of the installing and maintaining the fuel tank and operating their fuel truck, as well as the taxes and fees were all excluded from their cost of fuel. Those costs were in the cost of the hangar and grounds throwing that benchmark off as well. So my intent was to arrive at the “Total cost of fuel inclusive of every cost of every item needed to get the fuel into the aircraft tank.” But without a lengthly definition and explanation, how is an operator to know exactly what I need?

When comparing costs, you need to be clear and consistent in what costs are included and how those costs are calculated.

Another area where costs can be reported in disparate ways is maintenance. “What is your cost of maintenance?” is such an open, and loaded question. Do you get your aircraft maintained at a service center? Do you have in-house maintenance staff? Do you have inventory and how/where does that cost get recorded? Did you record the costs as an accrual or as they occurred?

As an example, take a major airframe inspection due every six years on a large business jet. The cost of that inspection is $240,000. As an answer to “what is your cost of maintenance?”, it could be:

1. $240,000 this year as the inspection was done this year ($600 per hour if flew 400 hours)

2. $40,000 per year accrual for six years (or $100 per hour is flying 400 hours each year)

While in our costing we look at the $100 per hour as the cost of the above inspection, neither accounting is incorrect. When comparing costs, we stress using an accrual method. This way the cost of something is allocated over the time it took to accrue that cost.

If budgeting, then you need to look at the timing of the cost. Comparing costs by looking at a budget can be helpful as it shows not only what the costs are expected to be, but when they are likely to occur. If you are evaluating the acquisition of a used aircraft, when the major airframe inspection is next due can be important. So while Both Aircraft A and Aircraft B can have a similar budget, Aircraft B may face that major inspection sooner than Aircraft A. This information is good to know.

Comparing aircraft costs should be done using a fair and consistent method. The timing of major costs should also be considered. While no one method is the best method, the comparison should be done on an “apples-to-apples” basis and then relative differences are what adds meaning to the comparison.

2013 Outlook for General Aviation

For our small company, 2012 was a decent year. We saw solid growth in our product sales. We were careful with our expenses and stayed profitable.  One thing I was encouraged about was that more of our customers are seriously looking at acquiring aircraft.  Based on last year, and whatever stuck me, here is my 2013 Outlook.

Globally, the economic recovery is expected to continue, slowly. Corporate profits and the stock market are generally improving. Developing nations globally are expected to grow Gross Domestic Product (GDP) at 4% to 5% with China closer to 7%.  So the global economy is expected to limp along with spots of higher growth. No inflation fears, yet.

One bright spot continues to be oil prices. Crude is back down around $100 a barrel with prices expected to stay stable into 2014. Look for fuel prices to be stable with one caveat.

Flying is still down. FBOs need to pay their bills and to offer those “free” services that we have come to expect. If five years ago that could be done at $0.30 per gallon added to the fuel price, with reduced fuel sales volume, today they might need $0.60n per gallon. So if you are seeing fuel prices increase, the cause is not the direct cost of the fuel, but the cost to provide all the other services that come with using the FBO. 

Regarding aircraft sales, I sound like a broken record: it is a buyers’ market. Still. Here in the US, 2013 will have the 50% Bonus Depreciation available for new aircraft and capital upgrades. This will be a help for selling new aircraft to profitable companies who are in need some short-term tax write-offs. 

These new aircraft sales will have an increasing adverse effect on used prices. None of the new aircraft manufacturers want to inventory used aircraft. So if they do take one in on a trade, they will be very anxious to resell it. 

According to Vref, the jet market still has falling prices across most of the jet market. Even the large-cabin jets. Turboprop prices are flat. Piston pricing is still down with few bright spots. Buyers continue to be very price sensitive. As always, aircraft in excellent condition will still sell first. But most important is price.

If you are selling, don’t think prices will creep up anytime soon (soon as in the next two years). If your turbine aircraft is older than age 10 to 15 years, its value will not recover. Don’t plan on buying an older turbine aircraft thinking its retail value will improve enough to earn a profit. But if the older turbine aircraft meets your needs, then now is a good time to buy.

The helicopter industry is one that is, partly joking, dependent on disaster! High oil prices mean more oil and gas exploration. That isn’t likely this year. Who knows what the fire-fighting season will hold, but government agencies won’t be wanting to support big price increases unless justified. Health care: costs are too high and insurance companies are fighting every aspirin and hip replacement. Don’t expect a willingness for insurers to pay more for EMS services. I do not see a strong year for the commercial helicopter industry. There is hope as developing nations start to expand their infrastructure for helicopters but that is still years away. Still, from what I hear, the single-turbine sales market should be OK this year, provided the price is right.

I see weak growth in aviation for at least the next two years, but growth nonetheless.  Now is the time to prepare for that growth, stay lean, and to invest in improvements in your business.

What about from where you sit? What do you see for 2013?

 

Pilot to Executive Speak

I think a requirement for being called a profession is to develop a set of buzz words and acronyms that only insiders, those of us in the loop, can know. Sort of the equivalent of a secret code so that we can identify each other. To a pilot, FAR, IFR and VFR all have very specific meanings. But a government contracting officer, FAR means Federal Acquisition Regulation. To a military researcher, FAR means Fuerzas Armadas Revolucionarias, Cuba’s military forces! To most people, FAR means a long way to go.

While acronyms facilitate communication within the loop, it obfuscates things for "outsiders." In aviation, most of our customers are outsiders: the executive, the accountant, the aircraft owner, etc.  To them, aviation folks might as well be teenagers texting - ROFL!

Effective communication depends on the sender and receiver being on the same frequency. It is all to common for us to misunderstand what was said, and also too common to remain silent rather than ask someone to restate it in plain English. Here are a three tips to help communicate airplane speak into common English.

Tip #1. Keep It Simple (Stupid) KISS.
If two pilots are talking about the weather, you can throw in acronyms to make the discussion clearer, and fast. But when the passengers get on board, you need to soften it a lot. You may need to explain what the term alternate airport means. "Because the weather is poor at our destination, we need to carry extra fuel in case we need to land somewhere else. Today, that alternate if further away than normal, so we need to carry even more fuel." This may ease the pain of the request to offload baggage or a passenger or re-plan the trip in extreme cases.

Tip #2. Be wary of the word "safety".
All our flying is "safe." But, sometimes, we need to or have to operate to different levels of safety. A Part 91 flight has more flexibility in what the rules call safe than a Part 135 flight. Excuse me: Part 91 means flights that are privately flow and not flown for hire, such as a corporate flight department's trip or an owner-pilot flight. Part 135 applies to charters and similar flights. Different rules, different requirements. Both are safe. In the case of in-house rules, the boss/aircraft owner needs to understand that your rules may be different than another operator's rules even though they may have the same aircraft.  When safety is the issue, by all means use that term. In other cases, maybe "margin for error" is a better term?

Tip #3. Understand that the same term may have different levels of meaning to the non-flyer.
An owner just had his plane in for a 2400 hour airframe check. During the check, the maintenance facility found corrosion in the tail. To the pilot or mechanic they know the corrosion is small, perhaps even invisible to the naked eye. The aircraft owner, however,  may think of a rusted bumper on a old car! So when explaining the corrosion to the aircraft owner, we need to explain that, for an aircraft, any corrosion is too much. We don’t want the owner to think the aircraft is about to fall apart in flight (thus violating Tip #2 above).

Why do you think those "Dummies" books sell so well? They take complex subjects and remove the acronyms and jargon to explain the basics in a refreshingly simple manner. In aviation we need to communicate with non-aviators on a daily basis. Technical jargon can confuse those who don't have the training and knowledge to interpret it. We need to explain what it means to them in terms that make sense - to them. Explain things in terms that your listener will understand in terms of their own experience.

(Please feel free to print this off and bring it to your next Doctor’s visit)

Tax Season Is Almost Here!

Ben Franklin supposedly said that in life, there are only two certainties - death and taxes. The former I'll leave alone, but do want to touch on the latter. Fiscal Cliff, fiscal road-bump, whatever it is called, may have an effect on both personal and corporate tax rates for 2013. I’m not offering tax advice, but just some food for thought.


An important note: while aviation taxes should not be a driving reason for an aircraft acquisition decision, the amounts can be substantial. Advance planning can potentially save thousands of dollars.


Here in the US, we essentially have two major taxing groups, the fifty states and the Federal Government. There are also a number of county and city tax authorities; some of these local taxes do apply to aircraft.


At the Federal level, the tax laws come via the Internal Revenue Service. The IRS separates aviation into two groups - commercial and non commercial. Don’t make the mistake that the IRS definition is in any way required to match that of the FAA Federal Aviation Regulations (FAR's) for commercial and non commercial operations. The IRS and FAA use different standards to define commercial operations and they have agreed to disagree.


The FAA uses regulatory definitions for a commercial operator. It involves the "intent" to hold one's aircraft out for hire. The IRS looks primarily at whether there is "transportation of persons or property for compensation or hire by air." Whether a profit is intended is not the IRS' concern. As Nel has stated ( click here for article), there are many times an operator is FAA Part 91 private but can be subject to IRS "commercial" taxes.


Many operators run afoul of the IRS in incorrectly figuring out how or whether to apply the Federal Excise Taxes (FET). Many local IRS offices are re-interpreting the FET law and are going after management companies. Add in the election year carriage of elected officials, transporting guests on corporate aircraft and international operations, and it can get confusing fast. 


Next are the 50 US States Departments of Revenue and local county/city tax authorities. They are all slightly different. Some apply sales taxes. The seller of an aircraft may be required to collect and remit sales taxes on the sale of an aircraft. Many states offer some exemptions or exceptions. Property taxes can be applied to aircraft - some being based on the percentage of time the aircraft spends in the state and others flat rated for aircraft based in their state.


There are use taxes and fuel taxes applied at the state and county level. Some of those taxes get applied to the state's aviation fund and other just go into the general fund. Again, there may be exemptions for commercial operators.


All these government entities are having trouble with getting revenue. Even if the Governor pledged no new taxes, that doesn’t mean that the state cannot get very tough on enforcing the statutes already in place. 


There are two words to the wise here.


  1. Paperwork is your friend, not your enemy. To prove that you do not owe certain taxes, you need to have the paper trail showing why. It can be tax receipts, aircraft registrations, hangar rent for the aircraft’s home base, whatever. Proper documentation is  your friend as a "paper trail" can provide proof of the taxable/non-taxable activity and or its intent.
  2. Plan Ahead for the aircraft transaction. Before taking action, find out what the options are and their costs. Just because you have a Delaware LLC does not mean that your tax planning is complete! Work with your tax accountant/CPA to gover over the tax implications (and FAA regulations don’t forget). Trying to do this after the fact often proves costly.


Taxes are not a reason to acquire an aircraft, nor are they a reason to dispose of one. But, taxes, when properly planner for and accounted for, can make the total cost of operating the aircraft lower than ignoring them and hoping for the best!


 

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